This spotlight explores the recent divergence between the growth rate of GDP in volume terms and measures of real income in Australia over the past decade. Decomposition of real income growth over this period shows that the trading gain from Australia's terms of trade has been the key reason for the increased growth of real income relative to GDP in volume terms.

THE SEQUENCE OF REAL INCOME ESTIMATES

Real(footnote 1) incomes are estimated following a series of steps outlined in the 2008 System of National Accounts. The sequence of real income estimates begins with GDP in volume terms. This is the value of the total production of goods and services within the Australian economy.

“1. Gross Domestic Product (GDP) in volume terms;

plus the trading gain or loss resulting from changes in the terms of trade (graph 3);

Each aggregate RGDI, RGNI, RGNDI, and RNNDI represents a further step away from domestic production in volume terms to "real" domestic income. This sequence represents a transformation from the total volume of goods and services produced in an economy to the real purchasing power of domestic income. The ABS publishes each of these aggregates with the exception of RGNDI.

DIVERGENCE BETWEEN GDP AND REAL INCOME GROWTH

Over the past decade, there has been an increasing divergence between the growth rates of real income and domestic production. Between 2002-03 and 2011-12, GDP in volume terms grew by 3.1% per annum on average while Real Net National Disposable Income (RNNDI; the final measure in the sequence of real incomes) grew by 4.1% per annum on average. Graph 1 shows the differences in growth rates as a generally increasing divergence between GDP and RNNDI. Over the past decade, the purchasing power of Australia’s domestic income has grown significantly faster than the growth of production of goods and services.

Real income and production, 1999-00 to 2011-12

The departure of real income growth from GDP in Australia is a recent phenomenon. Table 1 shows the departure of RGDI from GDP by the average growth rates for GDP and RGDI per decade over the past 40 years. The rate of growth of RGDI relative to GDP is not only greater over the last decade but also has been sustained for a greater period of time than previously observed.

Table 1: Average decade growth of GDP and RGDI, 1971-72 to 2011-12

1971-72 to 1980-81

1981-82 to 1990-91

1991-92 to 2000-01

2001-02 to 2011-12

%

%

%

%

GDP in volume terms growth

3.0

3.1

3.6

3.1

RGDI growth

3.3

3.1

3.6

4.3

Source: ABS Cat. No. 5204.0, Table 1.

Note: Average growth in chain volume measures

Graph 2 shows the changes in the growth of real income over the last two decades. The growth paths of GDP, RGDI, and RNNDI were very similar but began to diverge after 1999-00. This is indicative of a significant change to the Australian economy over the most recent decade. The following sections will analyse the changes contributing to the growth of real income relative to GDP.

Gross Domestic product and real income, 1985-86 to 2011-12

THE DIVERGENCE OF GDP AND RGDI

The first step in the sequence of real incomes is the addition of the trading gain or loss resulting from the terms of trade, to produce RGDI. The trading gain or loss resulting from the terms of trade is derived from the relative prices of exports and imports, and their relative volumes. Graph 3 shows the contribution of the effect of the trading gain or loss resulting from the terms of trade on real income growth. This effect has been the significant driver behind real income growth, visible from the consecutive years of strong growth since 1999-00.

Terms of trade effect, 1985-86 to 2011-12

Generally, while the trading gain has been strongly positive since 2003-04, this has not been due to an increase in the volume of exports relative to imports. Over the past decade, expenditure on imports against exports in volume terms has reduced real income growth over the same period (graph 4).

Net exports contribution to gdp growth, 1986-87 to 2011-12

While the net volume of exports had a significant impact on GDP growth (and also real income growth), the real driving force behind growth in real income has been changes to the relative prices of exports and imports. These relative prices, the terms of trade, have undergone a significant increase over the past decade (graph 5). Although there were large movements in the volumes of net exports in the late 1980s and early 1990s (graph 4), these changes did not create similar differences between GDP and RGDI growth rates due to the lower terms of trade prevailing at the time.

Australian terms of trade, 1985-86 to 2011-12

REAL GROSS NATIONAL INCOME

The second step in the sequence of real incomes is the allocation of primary incomes to and from residents and non-residents, to produce RGNI. Primary incomes are those incomes gained as a consequence of involvement in the process of production. The RGNI effect captures the inflow of income attributable to production occurring overseas, but which accrues to Australian residents (an income gain), and the outflow of income attributable to production occurring domestically, but which accrues to non-residents (an income loss). The net primary income effect is the combination of these two opposing income flows. Graph 6 shows the contribution of net primary income payable abroad to real income. The effect has varied between a +/-1% contribution to real income growth over the past decade.

Net primary income payable abroad effect, 1986-87 to 2011-12

The compounding effects of the growth rates shown in graph 6 are illustrated in graph 7. Generally, net primary income payable abroad has been a minor detraction from the growth of real income.

Real gross income, 1985-86 to 2011-12

REAL GROSS NATIONAL DISPOSABLE INCOME

The third step in the sequence of real incomes is the allocation of current transfers payable to and receivable from abroad, to produce RGNDI. Current transfers are those where goods and services are provided without compensation from the counterparty. Examples of current transfers abroad include donations to, or from, foreign governments or non-government organisations. Other forms of current transfers include social benefit payments and current taxes on income or wealth paid to, or received by, non-residents. The impact of net transfers payable abroad on real income growth have been quite small (graph 8).

Net transfers payable abroad effect, 1985-86 to 2011-12

Generally, the difference between the rate of growth of RGNI and RGNDI shows Australia has been a net recipient of current transfers to and from abroad (graph 9).

Real gross national income, 1985-86 to 2011-12

REAL NET NATIONAL DISPOSABLE INCOME

The final real income aggregate, RNNDI, measures the real purchasing power of domestic incomes after accounting for the consumption of fixed capital. Consumption of fixed capital is an estimate of the decline in the current value of the stock of produced fixed assets through physical deterioration, obsolescence or normal accidental damage. Fixed assets are those non-financial assets which are used repeatedly in the production process, yielding future economic benefits to the owner. Consumption of fixed capital is conceptually similar to commercial accounting depreciation(footnote 2) . Graph 10 shows that the consumption of fixed capital effect has detracted from Australian real income growth over the past two decades.

Consumption of fixed capital effect, 1985-86 to 2011-12

The consumption of fixed capital effect represents the decline of the expected value of returns to the stock of produced fixed assets within the Australian economy. The cumulative effect of that decline on real income is shown by the difference between RGDI and RNNDI growth rates in graph 11.

Real gross and net national income, 1985-86 to 2011-12

REAL INCOME AND GDP GROWTH OVER SELECTED PERIODS

Table 2 decomposes real income growth, as the average difference between GDP in volume terms and RNNDI, for selected periods between 1986-87 and 2011-12. Terms of trade changes have been the most significant contributor to real income growth relative to GDP in most of these periods. Net primary income payable effects have also become more important over the last decade.

Table 2: Composition of real income growth, 1986-87 to 2011-12

1986-87 to 1989-90

1990-91 to 1991-92

1992-93 to 1999-00

2000-01 to 2002-03

2003-04 to 2006-07

2007-08 to 2011-12

%

%

%

%

%

%

GDP in volume terms growth

3.9

-

4.2

3.0

3.5

2.7

Average terms of trade effect

0.8

-0.7

-

0.3

1.7

1.2

Average net primary income payable abroad effect

-0.4

0.3

0.1

-

-0.5

0.3

Average net transfers payable abroad effect

-

-

-

-

-

-

Average consumption of fixed capital effect

-0.2

-1.1

-0.1

-0.2

-0.2

-0.2

RNNDI growth

4.2

-1.4

4.3

3.1

4.5

3.9

- nil or rounded to zero (including null cells)

Source: ABS Cat. No. 5204.0, Table 1

Note: Average growth in chain volume measures.

NATIONAL ACCOUNTING TREATMENT OF INTERNATIONAL INVESTMENT

The divergence between estimates of real incomes and GDP has resulted in more scrutiny of real incomes as indicators of economic growth. This has highlighted some inconsistent treatments of investment earnings in national accounting statistics. For example:

The Switzerland Central Bank reacted to the divergence between real income estimates and GDP by experimentally compiling Swiss GDP on a ‘nationality’ basis, rather than a ‘residency’ basis. This included income earned from Swiss investment enterprises in other countries in the calculation of GDP.

The ABS also explored the allocation of company retained earnings due to foreign ownership with respect to real income. The ABS found that the current treatment of company retained earnings did not understate, with great significance, the income that may be attributable to non-residents with shares in Australian companies.

ANALYTICAL MEASURES OF INCOME, SAVINGS AND WEALTH

In addition to real incomes, purchasing power is also possible from accumulated wealth. The ABS publishes annual analytical measures that take into account not only real incomes, but also capital gains and losses due to valuation changes, destruction of assets and discoveries of new assets. See Australian System of National Accounts (cat. no. 5204.0), table 12.

CONCLUSION

The trading gain from the Australian terms of trade has been the significant driving force for the increase in real income growth rates relative to GDP and the departure from a long term trend where real income growth closely mirrored GDP growth. The increase in real income relative to total production of goods and services has justified the ABS selection of RNNDI as the primary indicator of economic progress in Measuring Australia's Progress: Summary Indicators, 2012 (cat. no. 1370.0.55.001). It is a more comprehensive measure of Australian economic welfare as it captures domestic production as well as the resultant purchasing power of domestic income.

1 Many flows in the SNA, such as cash transfers, do not have price and quantity dimensions of their own and cannot, therefore, be decomposed in the same way as flows related to goods and services. While such flows cannot be measured in volume terms they can nevertheless be measured “in real terms” by deflating their values with price indicies in order to measure the real purchasing power over some selected basket of goods and services that serves as the numeraire (2008 SNA, paragraph 15.181). <back2 Consumption of fixed capital is dependent on the current value of the asset and so the future income possible from the asset, whereas commercial accounting depreciation is used in the context of writing off historic costs. <back